The $1.2 billion in missing MF Global Inc. customer funds began to flow out of the brokerage on Oct. 26, five days before its collapse, as computers and employees fell behind margin calls and demands for collateral, according to a trustee’s investigation.

James Giddens, the trustee overseeing the brokerage’s liquidation, said in a statement today that MF Global regularly used money from the segregated accounts of commodities customers to finance daily activities. A rush to meet collateral requirements led to billions of dollars in securities sales, credit draws and inter-company loans to foreign affiliates, he said.

“For three months our investigative team has worked to understand what happened during the final days of MF Global when cash and related securities movements were not always accurately and promptly recorded due to the chaotic situation,” Giddens said. He cited complex transactions such as off-balance-sheet repurchases involving sovereign debt and derivatives.

During the firm’s final days, MF Global took out larger amounts as customers fled, he said. A chart filed with his report shows how an excess of customer money quickly turned to a shortfall.

The company needed about $6.75 billion in funds segregated for its customer accounts Oct. 24 and 25, and had more than $7 billion.
Margin Call

On Oct. 26 the company got a $108.8 million margin call, and a steep decline began, with segregated funds falling to $4.5 billion by Oct. 28, a billion less than was required.

On Oct. 31, the brokerage’s final day, it had a $310 million margin call tied to its European sovereign debt trade.

The trustee didn’t disclose the parties making the margin calls. Transactions traced in the investigation cover 47 bank accounts at eight financial institutions, he said.

According to a footnote, an initial calculation by MF Global had contained an error, and the segregated amounts held in bank accounts had been overstated.

The New York-based brokerage moved $105 billion in cash in the week before its parent, MF Global Holdings Ltd., filed for bankruptcy and made $100 billion in securities trades, according to the statement. The trades included liquidating customer securities and the firm’s own positions. After tracing 840 transactions worth $327 billion, Giddens is still analyzing where some of the money “ended up,” he said.
‘Larger Amounts’

MF Global Inc., the brokerage, often moved money between its own accounts and those of customers in amounts of less than $50 million a day, replacing the cash by day’s end, according to the report.

As cash demands on the firm surged in the last week of October, “much larger amounts were used, apparently with the assumption that funds would be restored by the end of the day,” according to the report. Starting on Oct. 26, “funds did not return as anticipated,” the trustee said.

Such mingling of firm money and customer cash isn’t a safe way to run a futures brokerage, said Darrell Duffie, a finance professor at Stanford University.

“The very practice of reaching into the same account doesn’t sound prudent to me,” Duffie said. Customer cash should be operationally distinct from any money belonging to a futures broker such as MF Global, he said.

Regulations allowed MF Global to use funds in the segregated accounts only for certain investments, with CME Group Inc., the world’s largest futures exchange, performing audits to check that the invested funds met segregation requirements.
CFTC Rules

One U.S. Commodity Futures Trading Commission rule requires that all customer funds be separately accounted for and segregated as belonging to commodity or option customers.

MF Global Holdings Ltd., once run by former New Jersey governor Jon Corzine, filed for bankruptcy on Oct. 31 citing credit rating downgrades tied to $6.3 billion in investments in European sovereign debt.

CME, based in Chicago, reviewed MF Global’s accounts the week of Oct. 24, and found them in compliance. MF Global didn’t report any transfers until early Oct. 31, suggesting the firm “made subsequent transfers of customer segregated funds in a manner that may have been designed to avoid detection,” according to a CME statement on Nov. 2.
Potential Lawsuits

The trustee said he has now traced how most of the more than $327 billion in transactions played out during the brokerage’s last days. The banks, clearing houses and customers that received the funds may be subject to lawsuits that seek to recover them on behalf of all customers that are missing funds from their accounts, Giddens said.

Giddens has already returned about $3.8 billion that was frozen in customer accounts, or about 72 percent of what customers are owed. He said he estimates that $1.2 billion or more is missing. Corzine has said he doesn’t know where the missing money is and didn’t authorize any misuse of customer money that may have occurred.

The brokerage is liquidating under Giddens through the Securities Investor Protection Corp. The parent’s Chapter 11 bankruptcy is being handled by a separate trustee, former Federal Bureau of Investigation Director Louis Freeh.
Class Actions

Corzine and other executives face two potential class actions over the collapse. Futures customers of MF Global Inc. are competing to lead a lawsuit over the alleged theft of $1.2 billion of their assets. An investor suit led by the Virginia Retirement System alleges that Corzine made misleading statements that inflated the prices of MF Global securities.

MF Global Holdings’ insurance unit issued $190 million of liability policies for Corzine, other professionals and the company through May to cover costs of defending against allegations of wrongdoing, Freeh said in a Feb. 3 court filing in Manhattan. The policies don’t belong to the bankrupt estate and the coverage should be continued, he said.

“Directors’ and officers’ insurance policies tend to be proportional to the size of the risks that the company might face if it does something wrong,” Nancy Rapoport, a bankruptcy law professor at the University of Nevada, Las Vegas, said in an e-mail.
Lehman Brothers

Lehman Brothers Holdings Inc., which filed the biggest U.S. bankruptcy in 2008, had $250 million of insurance for civil, criminal and regulatory claims through last year. The defunct investment bank said in August that former executives including ex-Chairman Richard Fuld would settle an investor lawsuit over losses on Lehman stock and options using a $90 million payment from insurers.

The MF Global policies, which have a deductible of $25,000 per single claim, cover the insured “for all loss arising out of a wrongful act which gives rise to a claim,” according to Freeh’s filing. The policies cover defense lawyers’ bills, as well as certain damages awards and settlements.

Andrew Levander, a lawyer for Corzine, didn’t respond to e- mails seeking comment on the lawsuits.

Separately, the MF Global parent and affiliates have a $15 million insurance policy from New Hampshire Insurance Co. for costs of defending against lawsuits, according to a December court filing. The insurer disclosed the policy in a request to a judge to let it pay MF Global and a defendant for costs incurred before and after the Oct. 31 bankruptcy.
Combining Cases

U.S. District Judge Victor Marrero has been combining the investor cases, saying they make similar claims that Corzine and other company officials made misleading statements about MF Global’s financial condition before its Chapter 11 filing.

The Virginia Retirement System, chosen by Marrero to lead the investor suit together with Canada’s Province of Alberta, said in a filing the two together lost more than $19 million on MF Global stock and debt.

The brokerage case is Securities Investor Protection Corp. v. MF Global Inc., 11-02790, U.S. District Court, Southern District of New York (Manhattan). The parent’s bankruptcy case is MF Global Holdings Ltd., 11-bk-15059, U.S. Bankruptcy Court, Southern District of New York (Manhattan). The main investor case is DeAngelis v. Corzine, 11-cv-7866, U.S. District Court, Southern District of New York (Manhattan).